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CLS: Federal Reserve – Money Market Funds – Bonds


Week in Review

Domestic stocks hit a rough patch last week, with small cap equities trailing their larger counterparts by a small margin. Taking a look at U.S. sectors, energy rallied last week (the only sector to post a positive return) due to a sharp rebound in oil, while industrials had the worst performance of all sectors. Markets were hurt on Friday amidst news of rising Greek default risk and a downgrade to their credit rating by S&P, in addition to an overnight outage of Bloomberg terminals. Emerging markets were the bright spot among equities, led higher by China after GDP contracted to 7.0%, increasing the likelihood of further stimulus.

Meanwhile, bonds were led higher over the week as economic data released was soft, creating more uncertainty around the timing of when the Federal Reserve (Fed) will begin to raise rates. U.S. industrial output decreased, housing starts were lower than anticipated, and while retail sales increased for the first time in months, they still came in lower than expectations. The U.S. 10-year Treasury yield fell, ending the week at 1.86%.

In other news, Nokia has agreed to purchase French rival Alcatel-Lucent in a move to boost its global telecom presence. Earnings releases reported that Goldman Sachs and J.P. Morgan Chase both were able to increase their revenue in the first quarter, a result of increased trading. Other industry giants, Citigroup and Bank of America, posted first-quarter profits despite a decrease in revenue, and while Wells Fargo’s earnings fell for the first time in years, they were still able to beat expectations.

Federal Reserve – What’s Next?

Data supports that the Fed will raise rates as soon as possible:

  1. Employment is likely near full-employment levels.
  2. Wage pressures are starting to increase, and the inflation data may have bottomed out.
  3. The financial markets are arguably overvalued.

Nonetheless, what the Fed should do and what they will do are two different things. Instead of raising rates in the weeks ahead, I think the Fed is more likely to raise rates in July or September, than in June; unless, of course, payrolls and inflation data both surge between now and then. Payrolls did surprise lower last month (though mostly due to the weather).

As for the impact of the Fed raising rates on the bond market, I think yields across all maturities will need to rise. This means that longer-term bonds will likely sell off as we get closer to the timing of the rate increases, though I do expect that the one- to five-year area will be hit the most. Future data will determine the long end of the curve.

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